Concerted Action Needed in Eurozone to Revive Growth and Jobs

Healthier, more integrated banking system needed to support recovery, restore confidence

Overcoming structural weaknesses is vital to long-term recovery

Support for demand essential until more comprehensive actions kick in

While substantial collective action has been taken to tackle the crisis in the euro area, further policy steps are needed to support growth and increase employment.

In its latest annual assessment of the euro area, the IMF said that these actions, if taken in concert, would be mutually reinforcing.

“Over the past year, substantial actions at both the national and euro-wide levels have been taken to combat the crisis," said IMF Managing Director Christine Lagarde. "But despite this progress, the economic recovery remains elusive, unemployment is rising, and uncertainty is high. Additional policy measures are required to fully restore confidence, revive growth, and create jobs."

The IMF acknowledged the positive impact of measures taken over the past year to combat the crisis, such as implementation of the European Central Bank’s (ECB) Outright Monetary Transactions framework, the completion of the European Stability Mechanism (ESM) firewall, and agreements on program countries. These steps have addressed immediate threats, but financial markets remain fragmented along national borders.

Also, in the face of lingering uncertainty and high debt, households and firms are postponing spending. With unemployment at record highs, especially among young people, the risks of stagnation and long-term damage to potential growth are increasing.

Four priority areas

The IMF assessment thus recommends giving priority to four areas of policy action:

• Restoring the health of banks’ balance sheets. To raise confidence, a credible assessment of the quality of banks’ assets is needed. Such an assessment would quantify capital needs and should be accompanied by a clear plan on how to meet these needs. Where private capital is insufficient, credible backstops—in some cases, the ESM—will be essential to preserve banks’ ability to continue lending.

• Completing the banking union. This would entail expediting reforms already under way, such as adopting the legislation for the Single Supervisory Mechanism and reaching final agreement on the Bank Resolution and Recovery Directive. It should also involve the introduction of a strong, single resolution mechanism that ensures swift resolution of banks, limiting the overall cost to taxpayers.

• Taking further steps to support demand in the near term. The IMF welcomed the recent introduction of forward guidance and the ECB’s commitment to keep the monetary policy stance accommodative for as long as necessary. The IMF also said that while monetary policy alone cannot address structural banking sector weaknesses, it can provide essential space, with additional conventional and unconventional measures as needed. In addition, fiscal adjustment in euro area countries should be carefully paced to avoid an excessive drag on growth.

• Pushing ahead on structural reforms. Tackling structural gaps—at both the euro area and the national levels—would raise potential growth and promote external adjustment within the euro area. Implementation of the Services Directive could encourage cross-border competition and raise productivity, while national efforts to address labor market weaknesses would boost competitiveness and employment.

Benefits of policy action

The IMF's Article IV assessment also noted that the benefits of a comprehensive reform effort—tackling financial fragmentation and structural weaknesses—could be significant over the medium term, potentially raising the level of euro area and global output, respectively, by about 3 percent and 1 percent within five years.

The IMF assessment was based on the preliminary findings of an IMF staff visit to the euro area. A final report will be issued once it has been discussed by the IMF’s 24-member Executive Board in the coming weeks.

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